30 Nov 2009

PRACTICAL LEASING STRATEGIES FOR LANDLORDS IN AN OVER SUPPLIED RENTAL MARKET

Authored by: Brent Baldwin

Ownership of an untenanted commercial investment property is not an ideal situation for a landlord. The landlord still has to pay all outgoings as well as maintain the property. The value of the property may be linked to the income stream associated with it by potential buyers and financiers alike. Empty commercial space can lead to significantly diminished property values. Brent Baldwin looks at alternative strategies that landlords should consider in improving their chances of attracting and retaining tenants.

In brief:

In a climate where rentals are significantly reduced and supply outweighs demand, landlords are struggling to retain and attract tenants.

Alternative “innovative leasing strategies” may be one way of attracting tenants.

There are a variety of contractual arrangements, tailored to the current market, that landlords can consider.

Vacancy rates for commercial properties are rising in Dubai and significant additional commercial supply continues to become available. At a time when rentals are already dramatically reduced, this puts further downward pressure on rent levels. If commercial landlords want to maximise their investment, it is critical to make their properties as attractive as possible in order to stand out from the crowd of landlords looking to stake their claim to a small pool of tenants. This issue is not limited to new buildings and landlords will also face the challenge of retaining their existing tenants who may be looking at more modern, less expensive space.

Given the increased competition in finding and retaining commercial tenants, landlords need to think of ways to improve the appeal of their properties and not compete on rent alone. One way landlords can do this is through developing innovative leasing strategies. By thinking “outside the box” and offering contractual arrangements that are tailored to the current market, landlords can significantly improve their chances of finding and retaining a tenant.

Some examples of alternative strategies follow.

Fit-out loans
An attractive inducement for a tenant can be the offering of an interest free fit-out loan. Under such an arrangement, the landlord will pay for the tenant’s fit-out (usually up to a capped amount) and the cost of this will normally be apportioned over the original term of the lease and repaid in addition to the rental. This substantially reduces a tenant’s initial set-up cost and minimises the need to find other more expensive funding.

Rent free/reduced rent period
In a difficult market it can be worth signing up a tenant for an initial rent free (or very low rental) period. Although some landlords may consider this unattractive initially, it does at least mean that the premises are not vacant. The landlord can arrange to recoup the discounted rental after a certain period when the economy has recovered or the tenant’s business achieves certain milestones. In addition, businesses (once established) are less likely to move if rentals remain comparable to market rate.

Marketing assistance
A landlord may consider contributing to a marketing fund without claiming the cost back from the tenant as a service charge. In a retail situation for example, if a landlord can demonstrate a genuine desire to improve the footfall in the premises this could entice a prospective tenant to accept a lease in those premises.

Turnover rental
This is an arrangement for the payment of rental based on turnover and is commonly used, even in better economic circumstances. A landlord may consider a low base rental and couple this with the ability to audit the tenant’s turnover and claim additional rental if the turnover reaches certain pre-agreed levels.

Flexibility regarding assignment/sub-letting
Some tenants do not want to commit themselves long term as they are unsure how their business might do in this economic climate. Some tenants may be more willing to take on a medium/long term lease if they know they can easily sublet space or assign the lease without onerous restrictions being put in place by the landlord. Such arrangements however, need to be carefully thought through so that the landlord does not find itself with an unsuitable tenant. One way for the landlord to do this is by being very specific about what they will accept if the tenant does find a suitable sub-tenant or assignee.

Use restrictions on other tenants
Use restrictions are typically found in retail mall premises and are used to protect supply in a particular tenant’s product or service range by ensuring no other tenants compete with them. The rigorous enforcement of such an agreement can provide the assurance the tenant needs to lease that space.

Absorb service charge increases
The tenant can achieve certainty in its budgeting if the landlord agrees to a gross rental that includes all service and management fees or agrees to cap service charge increases. Although the landlord may then have to absorb increases in those costs, if this mechanism serves to encourage a tenant to take on a lease, this will generally be a better option than having the premises stand empty for uncertain periods.

Break clauses
Landlords, in order to protect themselves if a tenant’s business fails to success or outgrows the leased space, can include a break clause in the lease as an attractive inducement. Such clauses typically allow a tenant to terminate a lease before the expiry date provided that they pay the landlord a pre-agreed amount in compensation eg. six to 12 months rent, depending on the length of the lease. A break clause may also minimise legal and administrative costs for the landlord should the tenant seek to terminate the lease without legal right. This is partly because a break clause can reduce the time spent dealing with unreasonable requests for termination where the tenant tries to create a dispute so as to claim a right of termination. This also gives the landlord time to find a new tenant without losing income for a certain period.

Rights to extend the premises in the future
A tenant that is optimistic about the future of its business but is still nervous about the current economic climate may not want to commit to a large space today however might have additional needs tomorrow. A binding contractual commitment on the part of the landlord to offer additional space in the future may entice the tenant to take a lease in its premises.

Conclusion
The above are some ideas of ways in which landlords can improve their prospects of attracting and retaining tenants in an over-supplied market. It is important to note however, that the way in which such clauses are used must be carefully considered and negotiated. If you are a commercial landlord wishing to discuss strategies to attract and retain tenants in the current market, our real estate experts are happy to discuss these and other options with you.